A couple days ago, the merger between US Airways (LCC) and American Airlines (AAMRQ.PK) became official where the two parties agreed on forming the world's largest airline by volume. According to the agreement, US Airways shareholders would own 30% of the new company, whereas the majority of the company would be owned by the creditors of American Airlines. The expected value of the merger was estimated to be between $11 billion and $13 billion. It looks like the current shareholders of American Airlines will be getting a tiny portion of the company while most of these investors will be in deep loss.
Since it will take a while before the two companies officially merge and go under one stock ticker, we don't have many ways to know how the investors are taking the news in. After all, just because the company is expected to trade for $11-13 billion doesn't make it so. For example, Facebook was expected to be valued at $100 billion, which the investors didn't agree with at the time. Regardless of everything else, a company is worth as much as investors think it is worth. This is one of the major principles of the free market.
As soon as the merger was officially announced, the share price of US Airways took a dive and fell by 5%. The merger values US Airways at $3-4 billion range; however, the investors currently value it at $2-3 billion range. While I always argued that US Airways is undervalued regardless of whether the merger happened or not, investors don't seem to cheer about the merger. Because US Airways shareholders will own roughly 30% of the new company and US Airways is currently valued at $2.3 billion, this values the new merged company at $7.67 billion as opposed to $11-13 billion range suggested by the analysts and the management. Will the investors close the gap between the two numbers by buying shares once the merged company trades under one common ticker? I think the answer is not very clear but it will definitely take some time before the investors start giving the company its true value.
When you think about it, roughly 70% of the new company will be owned by the creditors of American Airlines, who want nothing but to get their investment money back. These are pretty much bond investors who are mostly not as interested in stocks. After all, they bought bonds of American Airlines rather than the stocks, which was a good decision for them since they are far more likely to get their money back than the shareholders. If these people want nothing but getting their money back, they are likely to sell their shares soon after receiving them. If a lot of people sell their shares all at once, this will suppress the stock price temporarily. This might be one of the reasons we are seeing the US Airways shares fall.
Apart from the psychology, the new company will have solid fundamentals. The merged company is expected to draw nearly $40 billion in annual revenues. Given the profit margins of US Airways and American Airlines in the last quarter, we are looking at $2 billion in annual earnings for the merged company. If this scenario actually materializes, the current shares of US Airways would be worth as much as $20 as opposed to the $14 they are currently trading for.
Things might not look as bright for the American Airlines shareholders though. The current shareholders of American Airlines will receive 3.5% of the new company, which values the current company at $380-400 million at best. Given the current valuation of US Airways, American Airlines might be worth as little as $300 million. Currently, the market value of American Airlines is $844 million, which means the holders of these shares will have to take a big cut when the merger happens.
To answer the question again, I don't think US Airways is currently valued in a way to reflect $11-13 billion valuation for the merged company. Investors might be skeptic or concerned about the true value of the merger. Given that the current shares of US Airways will make up 30% of the merged company, I would expect US Airways shares to be a good proxy of where the merged company's shares will be in the future. This will be interesting to wait and see.
I am still long with US Airways and I will continue to be until the merger. Once the merger finalizes, I might keep or sell my shares depending on the situation.
Disclosure: I am long LCC.